Does The Philippines Deserve Its Investment Grade?

Over the past decade the Philippines' sovereign credit rating oscillated between "negative" and "stable," reflecting concern about the ability of the government to collect sufficient tax revenue, manage its budget, and sustain a high rate of GDP growth.
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Over the past decade the Philippines' sovereign credit rating oscillated between "negative" and "stable," reflecting concern about the ability of the government to collect sufficient tax revenue, manage its budget, and sustain a high rate of GDP growth. Three years ago, President Aquino embarked on a long overdue path to correct what had become endemic deficiencies in the Philippine economy. Over the past 10 weeks, the country has been rewarded for its efforts, with Fitch, the Japan Credit Rating Agency, and S&P all categorizing the Philippines as "investment" grade. Does it really deserve that designation?

Moody's retains its rating at a notch below investment grade, but will undoubtedly follow the others in due course, reflecting a rising chorus of voices in the investment community expressing confidence in the country's future. The external position of the Philippine economy -- its current account balance, external payments position, and foreign exchange reserves -- has been solid under President Aquino's fiscal management. The public deficit (2 percent of GDP) and debt-to-GDP ratio continue to fall, inflation remains at 3 percent, and the country's GDP in 2012 grew at 6.6 percent -- higher than Indonesia (6.2 percent) and Malaysia (6.0 percent), and not far behind Asia's perpetual economic leader, China (7.6 percent). Year to date, the Philippine peso and stock market (ranked 5th best globally) are among the best performers in the world.

Cleary, much of the credit must go to the President, and his willingness to tackle some long simmering issues. Since taking office in 2010, President Aquino managed to pass the 'sin tax' law covering such items as alcohol and cigarettes, increased tax collection rates, and successfully impeached the now former Supreme Court chief justice of former President Arroyo, on grounds of undeclared wealth. Because of Aquino's "straight path" platform, the Philippines ranked 105th (out of 174) in Transparency International's Corruptions Perceptions Index in 2012, on par with such countries as Algeria and Mexico. When he assumed power, the country was ranked 134th, on par with countries such as Nigeria and Zimbabwe. Clearly, the country is making good progress in that regard.

But what progress has been made in terms of simply doing business in the Philippines? Despite its newly minted investment grade credentials, the World Bank's 2013 'Doing Business' indicators continue to give the Philippines a low grade. Out of 185 countries in its index, the Philippines ranks just 138th, sandwiched between Ecuador and the Ukraine. In six of the ten categories, the country ranks in the lowest third, and particularly poorly in terms of both starting a business and resolving insolvency (at 161st and 165th, respectively). Also, the Philippine rankings actually fell in 7 of the 10 categories since last year. This stands in stark contrast to what is implied by its investment grade ranking.

Beyond the ease in doing business, regulatory risk remains a challenge, and the country's judiciary remains notoriously corrupt. While the political risk associated with attempted coups over the past several decades has notably diminished in recent years, election-related killings and violence remain a problem. And the country's rising level of net foreign direct investment remains a fraction of that of its neighbors, or other investment grade countries throughout the world. Given all this, what explains the relative haste with which the three ratings agencies upgraded the Philippines?

Apart from perhaps wanting to maintain a sense of consistency, given that Indonesia was also recently upgraded to investment grade by Fitch and Moody's -- even though its currency has not performed as well and it incurred its first current account deficit in 15 years last year -- one explanation might be a tendency to overemphasize a country's external profile while underemphasizing development indices such as the inclusivity of economic growth, per capita development across social strata, the Gini coefficient, and absolute poverty.

Recently, the Philippine National Statistical Coordination Board reported that despite the series of consecutive credit rating upgrades made by various agencies over the past 3 years, poverty levels in the Philippines remain unchanged. As of 2012, about 22 percent of Filipino households were considered poor by absolute standards, compared to 23 percent in 2009. A 2008 Asian Development Bank study stated that the Philippines has the largest number of higher education institutions in Southeast Asia, and the number of examinees in professional licensure exams continues to rise, yet passing rates continue to drop. In addition, the Philippine underemployment rate increased from 19 percent in 2011 to 22.7 percent in 2012. In other words, some important, underappreciated indicators are going in the wrong direction.

The Aquino administration has been quick to focus on how long the "trickle down" process can take, but it did not dispute the findings of the report. To date, President Aquino's technocrats are struggling to reconcile high credit scores, on one hand, and inclusive growth, on the other. So far, there has been no adequate reason cited -- other than Kuznet's inverted-U curve (circa the 1950s), where income inequality should eventually decrease, but only after sustained growth in the long term. On that basis, the Philippines must have high sustained growth for many decades to make a real difference in the absolute poverty rate.

So this appears to be a "Tale of Two Countries" -- one with significantly improving economic indicators and an activist President determined to smash through some of the unfortunate legacies of the Post-Marcos era, and the other -- an unbroken legacy of poverty, regulatory ineffectiveness, and judicial corruption. The ratings agencies appear to have focused primarily on the former, presumably under the assumption that it will take time to address the latter.

Much will depend on what happens after President Aquino leaves office in three years time. Will his reformist legacy continue, or will the country slide back into its old ways? At least three ratings agencies appear to be saying that there is a better chance that meaningful reform will continue in the longer-term. Clearly, the Philippines has a great deal of untapped potential. Nouriel Roubini, a perennial pessimist, forecasted that should the Philippines continue to defy the global recession, and if it were to consistently register GDP growth rates between 7 percent and 9 percent annually, as one HSBC study claimed, the Philippine economy may be among the largest economies by 2050. This assumes an uninterrupted path to nirvana, however, which is rather unlikely to occur, particularly given the vicissitudes of the global economy and the plethora of challenges facing the Philippines.

More likely is that the country will encounter its share of obstacles along the way, some of which will be externally derived, but many of which will undoubtedly be self-imposed. To truly deserve its investment grade rating, the Philippines needs to achieve much outside the realm of economic indicators. Being rated, as it is, one notch above junk status, it wouldn't take much for the country to fall back below an investment grade rating. Rather than beating its chest too much about what it has just achieved it, the government would be wise to focus on how best to avoid losing it.

Edsel Tupaz is owner of Tupaz and Associates and a professor of international and comparative law, based in Manila, Philippines. He is a graduate of Harvard Law School and Ateneo Law School.

Daniel Wagner is CEO of Country Risk Solutions, a cross-border risk management consulting firm based in Connecticut (USA), and author of the book "Managing Country Risk".

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